The Causal Effect of Institutional Ownership on Firm Level Risk Characteristics

Farid Radmehr and Tolga Cenesizoglu
Working paper #2
Retirement and Savings Institute – March 2019

We establish the causal effect of institutional investor ownership on a firm’s total risk, including its systematic and idiosyncratic components. The former captures the broader market risks for the sector whereas the latter captures risks that are unique to the firm. We use the Russell 2000 index membership as an instrument for institutional investor. We find that for a median Russell 1000 firm, an increase in institutional investor ownership (by one standard deviation) in a given quarter, causes a decrease in idiosyncratic volatility of 13.3% in annualized terms, which results in a decrease in total volatility of 12.8%. Institutional investors achieve this effect on a firm’s risk characteristics partially through their effect on its financial performance, as measured by unexpected earnings. More precisely, an increase in institutional investor ownership improves a firm’s financial performance, which decreases its total and idiosyncratic volatility.